The Job Market Has Room to Run—if the Federal Reserve Lets It

While the U.S. labor market is doing OK, it could be doing even better had the Federal Reserve not been misled by data on employment growth that has since been revised.

U.S. job growth has clocked in at just 1.3% over the past 12 months, Friday’s nonfarm payrolls report shows, which is significantly slower than the recent peak of 2.2% in 2014 and the slowest growth rate since 2011. That sounds bad, but other labor-market indicators—particularly the share of Americans with a job and the growth rate of hourly pay—suggest conditions for American workers are reasonably solid.

The recent slowdown is partly a function of the slow pace of the recovery in the years immediately following the financial crisis. In the past, sharp downturns were followed by sharp recoveries that were then followed by slower expansions. While that pattern was already breaking down in the early 1990s and early 2000s, the U.S. economy took so long to heal from the housing bust and subsequent financial crisis that the “normal” slowdown has only just begun to kick in a decade after the trough.

The easiest way to see this is to look at the share of Americans with a job, particularly those between the ages of 25 and 54 who are least likely to be in school or retired. About 80% of these prime-age Americans had a job in 2007. That share plunged to 75% by the end of 2009 and had recovered only to 76% by the end of 2013. Not surprisingly, job growth in those years was sluggish.

Eventually, however, a combination of mortgage defaults and rising home prices had restored household balance sheets just as the negative impact of government budget tightening had run its course. The result was a mini-boom in 2014 that convinced Fed officials that the U.S. had finally reached “full employment”—even though the share of prime-age Americans with a job remained far below its earlier levels.

The Fed was focused on the overall unemployment rate, even though it is a flawed indicator of cyclical conditions. Back then, monetary policy makers believed declines in the jobless rate past 5.5% would lead to unwelcome accelerations in pay increases—and eventually generate excessive consumer-price inflation. That belief helped push up the value of the dollar by nearly 25% while driving down the price of oil. Together, these dynamics crushed exports and business investment far more than they lifted household spending.

The yearly growth rate of U.S. economic output slowed from 4% in the beginning of 2015 to just 1.3% by the middle of 2016. Job growth slowed markedly and wage growth stopped accelerating. Nevertheless, the share of prime-age Americans with a job continued to climb, albeit at a slower rate than before.

By 2017, things had changed again. The dollar had stopped rising and oil prices had stopped falling, which encouraged businesses to resume investment. At the same time, higher military spending and tax cuts meant the government had switched to stimulus for the first time since 2010. Wage growth finally accelerated from 2.5% in 2017 to 3.5% in 2018, while the share of prime-age Americans with a job rose slightly faster than it had in 2015-16.

However, the job gains in 2018 now look less impressive than first reported. On Aug. 21, the Bureau of Labor Statistics revealed its initial estimate of the number of jobs in March 2019 was overstated by 0.3%. That may not sound like much, but it means the number of jobs added between March 2018 and March 2019 was overstated by roughly 25%.

Before the revision, it looked as if job growth had accelerated from 1.5% in 2017 to 1.8% in 2018, only to slow dramatically this year. Now it looks as if job growth held steady at 1.5% the entire time before modestly decelerating this year.

The economy has slowed since the middle of 2018 thanks to the combination of fading fiscal stimulus, the global manufacturing slowdown, and, ironically, monetary tightening that was motivated in part by the apparent strength in job growth that has since been revised away.

The result is that wage growth has stopped accelerating, employment growth has ticked lower, and, most notably, the share of prime-age Americans with a job has flat-lined at a level significantly below the 1999-2000 average.

After subtracting inflation, wage growth is now close to the rate reached during previous cyclical peaks in the late 1990s and 2006. Nevertheless, there are reasons to think wages ought to accelerate further. While the share of U.S. national income earned by workers has steadily increased since 2014 as a consequence of the improving job market, it remains depressed relative to the 1970-2002 average by about 2 percentage points.

As Fed Vice Chairman Richard Clarida has noted, this creates space for worker pay to rise significantly faster than inflation without undermining economic stability. For that to happen, however, the economy will have to run hotter—something the Fed seems increasingly willing to tolerate.

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